Liberalisation measures encourage private investment

The regulatory environment for business can have a determining influence on private investment (World Bank 2004). Complex regulations and bureaucratic hurdles tend to increase the transaction costs of doing business and thereby hurt the growth of investment. On the other hand, enabling regulations that protect investor interests and simplify business transactions encourage private investment.  In today's globalised world where capital is fairly mobile, weak domestic investment climate riddled with too many regulations and bureaucratic hurdles will not only adversely affect the inflow of foreign investment but can also cause domestic capital flight to more hospitable investment environment.   
The development experience of South Asia, especially India, provides an important example of how regulatory burden can overwhelm and choke private investment.  While all South Asian economies started their development journey on the wrong footing with over-dose of regulations, the Indian investment climate for private investment in particular had the dubious distinction of being dominated by the "license raj". Subsequent deregulation drive in India since the 1980s ushered in a sea change in the investment climate for private investment that led to a major private sector-led growth experience.  
LESSONS OF BANGLADESH EXPERIENCE: Per capita GDP (gross domestic product) in Bangladesh has grown at a steady pace since independence, climbing from an average of below 2.0 per cent during 1974-1990 to 5.0 per cent in 2010-14 (Figure 1).  The acceleration of per capita GDP during 1991-2014 is remarkable and it laid the foundations for Bangladesh to move towards low middle-income status (Figure 2).  A review of determinants of growth shows that the accumulation of capital was the most important determinant of growth (World Bank 2012). This is consistent with the growth experiences of East Asia when they started their journey from their low-income stage. While there is tremendous scope for improving the contributions of labour force growth, human capital and efficiency of factor use (total factor productivity), the accumulation of capital will continue to be a major driver of growth in Bangladesh in the coming years.
The long-term investment trend is shown in Figure 3. The investment effort in both public and private sectors started rising from the very low base in the early 1970s but remained weak well until 1989 hovering on average around 5-6 per cent of GDP for each. Indeed, in this sense and from a historical perspective, public investment took the lead based on generous availability of official development assistance.  

The public investment effort gained some momentum until 2000 but moved to a declining path as ODA (official development assistance) flows moved to a declining trend and public resource mobilisation effort did not gain adequate speed.  Indeed, this trend continued until 2009 when the public investment rate fell to a low 4.0 per cent of GDP, down from a peak of 7.6 per cent in 1994 and 7.4 per cent in 2000.  There has been an important recovery in public investment since 2010, growing to 5.7 per cent of GDP in 2014, but it remains below what is needed.     
On the other hand, the private investment effort accelerated after 1989 in response to the initiation of various liberalisation measures, especially investment deregulation.  Private investment climbed from a low of 6.0 per cent of GDP in 1989 to 20 per cent of GDP in 2009. In many ways these 20 years transformed Bangladesh from a public investment-driven and regulated economy to a private investment-led economy.   Unfortunately, however, the private investment momentum has shown signs of stagnation at the 20-21 per cent of GDP rate over the past five years.
This rate of investment is still a solid effort and is adequate to support the 6.0 per cent overall and 5.0 per cent per capita GDP growth of the past four years but this is not adequate to take the economy to the next stages of the development path involving 7-8 per cent overall GDP growth and 6-7 per cent growth of per capita GDP.  Another concerning factor is that the response from foreign direct investment (FDI) has been positive but lacklustre (Figure 4).  Although FDI flows have picked up recently, reaching $1.6 billion in 2013, this is still much below potential.  Total FDI flows in Bangladesh are relatively insignificant in relation to total supply to developing countries. For example, as compared with $1.6-billion FDI inflow in Bangladesh in 2013, FDI inflows amounted to $124 billion in China, $29 billion in India, $18 billion in Indonesia and $9 billion for Vietnam.   
Indeed, both public and private investment rate must expand to move to the 7-8 per cent GDP growth path.  The investment rate needs to go up from the present 26 per cent of GDP to 32 per cent of GDP to achieve 7.0 per cent growth rate by 2020 and to 36 per cent to achieve 8.0 per cent growth by 2020.  As in the past, the momentum has to come from private investment. Indicative growth scenarios suggest that the private investment rate should grow from the 21 per cent of GDP now to at least 27 per cent of GDP while the public investment rate should climb to 9.0 per cent of GDP from 6.0 per cent now to achieve a GDP growth rate of 8.0 per cent by the end of 2020.  
These are fairly steep challenges.  Achieving a 6.0 percentage point of GDP increase in the private investment rate in the next five years is not an easy task, especially in view of the stagnation in the investment rate over the previous five years. Substantial changes will be needed in the policy framework for private investment, especially to attract higher FDI inflows.
The objective of this exercise is to highlight the main regulatory constraints to private investment, both domestic and foreign, based on available evidence from Bangladesh investor surveys and cross-country experiences. It is important to note that the regulatory environment is only one, although critical, factor for private investment. Other factors include macroeconomic policies, infrastructure supply, land and labour supply, and political stability.
PROGRESS WITH THE ENABLING ENVIRONMENT FOR PRIVATE SECTOR: The rapid growth in private investment rate from 6.0 per cent of GDP in 1989 to 20 per cent in 2009 did not happen by accident.  A number of good policies including sound macroeconomic management, trade and investment deregulation, the expansion of infrastructure services and expansion of labour and quality improvements contributed to that effort.   A brief summary of these policies are provided here to set the basis for future reforms.
Sound macroeconomic management: Barring the early years of independence, sound macroeconomic management has been a hallmark of economic policy making in Bangladesh. Occasional hiccups and deviation from this path were quickly corrected and on average the long-term trend of various macroeconomic management indicators show a facilitating environment for the expansion of private investment.  These include low fiscal and current account deficits, prudent monetary policy, and flexible management of the exchange rate.  As a result, the long-term inflation rate has been in single digit, real interest rate has been relatively stable and the real exchange rate has avoided extended periods of real appreciation.  Total debt to GDP ratio is low and declining and external indebtedness is very manageable.  The stability of the macroeconomic environment has been a major enabler of the rapid expansion of private investment.
Investment deregulation: In the 1970s and 1980s Bangladesh manufacturing and organised services were characterised by the domination of state-owned enterprises and state controls over prices, investment and external trade. The deregulation process started in the 1980s but gained momentum after 1989.  Since then, there has been a major and progressive investment deregulation to boost domestic and foreign investment.  The deregulation effort has involved privatisation, removal of quantitative restrictions, simplifying business registration process and encouraging foreign investment through relaxation of ownership restrictions.
Foreign currency restrictions on inflow of foreign investment and outflow of profits have also been progressively eased including very recently foreign private borrowing for investment, although there is scope for improvement.
Trade liberalisation: Much of the trade liberalisation happened during 1990-2005. Although Bangladesh was a late starter compared with other developing countries including in South Asia, the magnitude of liberalisation is impressive when measured against the starting point.  This involved virtual dismantling of almost all quantitative restrictions on trade, sharp reduction of average trade tariffs and the establishment of the free trade zones (Export Promotion Zones (EPZs).
The hugely positive response of the readymade garments (RMG) sector to trade liberalisation and related other policies (such as back-to-back LCs, fiscal incentives and access to concession trade finance) is illustrative of the role trade liberalisation in promoting investments, exports, GDP growth and employment.
Fiscal incentives: To attract foreign investment and promote domestic investment the Government offers a fairly liberal set of fiscal incentives involving tax holidays, lower income tax rate, accelerated depreciation and low import duties on imports of capital and intermediate goods.
Exports also enjoy duty drawback benefits.  In many ways, the fiscal incentives in regards to exemption of profits or low rates offered to selected sectors (RMG, for example) might be too liberal and an overkill and as such needs to be re-examined to avoid an unnecessary erosion of the tax revenue base.
Supply of labour and employment policies: The abundant supply of labour is a major positive contributor to private investment and expansion of manufacturing production and exports, especially in RMG. Low wage cost remains a major advantage for Bangladesh that contributes to cost competitiveness in labour-intensive manufacturing such as RMG.   Government policy in regards to education and labour markets has played an important facilitating role.
Bangladesh labour markets relating to all three major sectors (agriculture, manufacturing and services) work flexibly and the transaction costs of employment in terms of hiring, termination and wage setting are among the lowest in developing countries - and certainly within  South Asia. While this flexibility is a big plus, recent developments in the RMG sector suggest that the absence of prudential regulatory norms regarding worker safety and social insurance, including coverage of accidents, is a serious problem that needs to be corrected.

Dr Sadiq Ahmed is Vice Chairman of the Policy Research Institute of Bangladesh (PRI).
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